Ackman or No, Air Products Is Solid

Two months ago we recommended Air Products & Chemicals (APD), and the stock has risen more than 8% since then. Since early June, two significant events have taken place. First, the company reported June-quarter earnings that were in line with expectations, with forward guidance tightened around the midpoint of the Street's prior expectations. Second, Pershing Square Management, the vehicle of activist investor Bill Ackman, disclosed a 9.8% stake in the company at the end of July. The latter event is what has caused most of the recent upward movement in the stock.

On Monday, Ackman came under pressure for being on the wrong side (so far) of high-profile investments in Herbalife (HLF) and J.C. Penney (JCP). Since Air Products is his latest foray, to the tune of $2 billion in open-market purchases, some observers are questioning the wisdom of this investment, as well.

While Ackman's history is not unblemished, Pershing Square has had a strong investment record. In fact, it has been a positive catalyst in a number of cases, especially when the target company has had a strong underlying business franchise.

We put Air Products into this category, as its competitive position is durable and sticky. Demand for its industrial gases should grow over time, given increasing worldwide manufacturing demand. Many of its customers are in stable businesses, such as food and beverage and healthcare. Others are more cyclical, like autos, energy and metals, and these should benefit as the global economy recovers.

Revenue and earnings growth stands to remain modest for the rest of this year, though the Street expects better growth of about 10% for the next two years on the back of solid bookings for new projects and contracts. Costs have been well contained, meanwhile, as management's priority is to maintain an attractive profit margin.

Air Products has a strong balance sheet, and it has demonstrated good annual dividend growth of 10% for the last few years. Its current yield is still above 2.7%, even with the run-up in the stock price this year. With increasing investor concern about upward-trending interest rates, this higher-yielding stock should actually have better fundamentals, if in fact the rise in rates is backed by accelerating economic growth. Finally, the stock is valued at 19x this year's earnings estimate -- which is not expensive, given the predictable nature of its business. It still trades at a discount to its peers.

We don't have any opinion on Ackman's plays in other stocks. But we do think that, in Air Products, he has uncovered a solid business at a reasonable price that will benefit from continuing economic recovery. If his activism can focus the company to pursue improved financial performance and shareholder returns, the stock can do even better.

We like Air Products at these levels, and if you own it, we recommend you continue to do so. For those who aren't invested, we suggest buying some based on Ackman's likely pressure on the company. With Ackman stirring the pot, we think the stock could move higher over the next year, into the $120-to-$125 range.

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